THE LAW OF LETTERS OF CREDIT

John F. Dolan

Wayne State University Law School Legal Studies Research Paper Series No. 07-36

April 2007

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The Law of Letters of Credit

John F. Dolan

Abstract: The Law of Letters of Credit Commercial and Standby Credits is the fourth edition of a traditional treatise on a rather narrow legal subject. Letters of credit fall into two categories: (1) commercials, which find use in international sales; and (2) standbys that are a common device in many domestic transactions. As international trade becomes more and more rationalized, the use of commercials has diminished; but the use of the standby has enjoyed something of a boom, for it accomplishes much that security interests, suretyship arrangements, and other credit enhancing devices accomplish and does it with significantly lower transaction costs. Regrettably, the parties using letters of credit often are unaware of the credits legal significance. This treatise covers the legal features of the commercial and the standby, all in a global context. While it is codified to some extent in the Uniform Commercial Code, the law of letters of credit is largely the law merchant, the ius gentium; and the UCC defers in many respects to international rules. Thus, the treatise deals with those international rules and cites cases from virtually all of the common-law jurisdictions in an effort to provide complete coverage of the field.

Copyright 2007 ALEX eSOLUTIONS, INC.

All rights reserved. No part of this publication may be reproduced in any form, by photostat, microfilm, xerography, or any other means, or incorporated into any information retrieval system, electronic or mechanical, without the written permission of the copyright owner. Inquiries regarding permission for use of material contained in this publication should be addressed to: A.S. Pratt & Sons 807 Las Cimas Pkwy, Suite 300 Austin, TX 78746 1-800-456-2340 www.aspratt.com ISBN 1-55827-716-1 Library of Congress Catalog Card No. 96-060045

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. In publishing this book, neither the authors nor the publisher is engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the individualized services of a professional should be sought.

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About the Author

John Dolan is Distinguished Professor of Law at Wayne State University Law School in Detroit. He has been a visiting professor of law at the University of Michigan, the University of California (Hastings College of the Law), twice at the University of Utrecht in the Netherlands, at Ave Maria School of Law, and at the University of Maastricht. He was also a visiting scholar at University College Dublin. From 1988 to 1991, Professor Dolan chaired the American Bar Association Letter of Credit Subcommittee and was a full member initially and, later, an ex officio member of the Task Force that studied letters of credit for the ABA from 1987 to 1989. He was an ABA adviser to the Drafting Committee of the National Conference of Commissioners on Uniform State Laws that prepared the 1995 version of Article 5. From 1988 to 1995, he served as a member of the Study Group on Trade Documentation of the U.S. State Department Advisory Committee on Private International Trade Law. He is a member of the American Law Institute and from 1990 to 1995 was adviser to the Restatement of Suretyship project. Professor Dolan has co-authored several textbooks and law journal articles. He was a member of the board of editors and an officer of the University of Illinois Law Forum (now University of Illinois Law Review). He also served on the board of editors of Letter of Credit Update from 1985 to 1987, is a member of the editorial board of the Banking Law Journal and the Journal of Payment Systems Law, and is a foreign contributing editor to the Banking & Finance Law Review (Osgoode Hall Law School, Toronto). Professor Dolan graduated from the University of Illinois College of Law in 1965, clerked for the United States District Judge in the Eastern District of Illinois upon graduation, and then practiced law full time for ten years before he entered law teaching.

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Preface
This fourth edition is intended to be permanent. It is necessary because the International Chamber of Commerce has promulgated UCP 600, which is effective for letters of credit issued on or after July 1, 2007, and it became apparent that much of this treatise merited revision. UCP 500, the 1993 version of the Uniform Customs, will continue to govern credits issued prior to July 1, 2007. This fourth edition discusses the major issues of letter of credit law with attention to both of those important documents. The publication of the third edition of this treatise, in 1996, followed two major developments in letter of credit law. In 1993, the International Chamber of Commerce had adopted UCP 500, which became effective on January 1, 1994; and in 1995, the Uniform Commercial Codes sponsoring agencies adopted a new letter of credit article (Article 5), which the state legislatures have now adopted. Courts continue to fashion a common law of letters of credit. The publisher and I plan to update this fourth edition, as we updated prior editions. This fourth edition, however, is permanent. Supplements will appear after the divider tab Cumulative Supplements. Each supplement enables readers to maintain a current, up-to-date revised edition. The text and footnotes will continue to incorporate the new and old versions of Article 5 and the new and old versions of the UCP.

ORGANIZATION
With few exceptions, the organization of the treatise remains the same. That organization permits those familiar with letters of credit to browse through the pages to find late developments and educate themselves in areas with which they are unfamiliar. The structure and sequence of subjects in the text rest on the assumption that many researchers read selectively. Moreover, the text takes pains to address issues that will interest those litigating letter of credit questions. But this edition is not simply a manual for seasoned letter of credit lawyers and bankers alone. It retains an organization that lends itself to the letter of credit novice. The first three chapters are introductory. Their role is to introduce the novice to the letter of credit as it appears in commerce and banking and to introduce the major themes of letter of credit law. That introduction is not easy. Letters of credit resemble contracts and secondary guarantees; and a primary objective of the first three chapters is to disabuse the reader of the notion that a modicum of 5/07 vii

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letter of credit learning coupled with some contract law and some suretyship law will yield efficient letter of credit law. The purpose of the first three chapters is to demonstrate that the formula spells trouble for letters of credit as commercial products and for the lawyer who tries to apply such law to them. The following chapters treat specific areas of letter of credit law. Chapter 4 describes the balance in letter of credit law among UCC Article 5, UCP 600 and UCP 500, the common law of letters of credit, various other legal regimes fashioned for letters of credit, and the law of contract. Chapter 5 makes the case for the special rules that govern the issuance, amendment, termination, and enforcement of letters of credit. Here, for the first time, the uninitiated will see how different letters of credit are from similar legal devices. Chapter 6 and 7 treat the heart of letter of credit law. They deal with the documentary compliance rules and the rules for stopping payment under letters of creditthe loci of letter of credit litigation. These chapters explain the two grand precepts of letter of credit law (the strict compliance rule and the independence principle) and make the case for discipline in letter of credit practice and enforcement. Chapter 7 also addresses the challenges that bankruptcy law poses for letters of credit when the banks customer, the applicant, becomes insolvent and the difficult, complex questions that the subrogation remedy raises for letters of credit. Chapter 8 is a short chapter with a measure of esoteric leaning on documents of title, security interests, and negotiable instruments law. Few treatises address these issues, but the questions they cover are important to the letter of credit issuer and to its correspondents, especially when they must look to the documents for reimbursement. This chapter deals with matters relating to bankers acceptances, negotiation credits, and the credit issuers rights to documents that arise in the transaction. Chapter 9 deals with remedies in the letter of credit context. The discussion illustrates the operation of unique letter of credit rules when the transaction breaks down. Chapter 10 deals with the unusual and somewhat opaque rules under which parties other than the letter of credit beneficiary may enjoy the benefit of the issuers undertaking. The rules are not always clear, are unique to letter of credit law, and permit letter of credit benefits to flow through to a number of parties: transferees, assignees, and negotiating banks. Chapter 11 addresses many questions that litigators face when they engage in suits arising out of the letter of credit. The features of the credit command unique rules of practice and procedure, and this chapter details them with special attention to the litigator who may be proficient in commercial matters but is unfamiliar with the letter of credit. Finally, Chapter 12 addresses specific issues that arise by virtue of the fact that most letter of credit issuers are commercial banks subject to a panoply of 5/07

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state and federal regulation. In particular, this chapter covers the knotty issues that arise in what one hopes is the rare case of bank insolvency. The law of letters of credit has not reached a stage of repose. Each year, courts decide letter of credit cases that demonstrate the growth of the credit as a commercial device and the development of the law to serve that commercial dynamism. In the meantime, this treatise will continue, as it has in the past, to provide comprehensive treatment of the subject and to report on late developments by means of periodic supplements. This work is now the most frequently cited source on letter of credit law. The publisher and I are committed to making this treatise a rich resource for lawyers and bankers as letters of credit play their role in commerce in this new century.

THE APPENDIXES
There are eleven appendixes. Appendixes A and B set forth both versions of Article 5, so that readers do not have to hunt for the version that is not effective in their state. The 2006 UCP (UCP 600) and the 1993 UCP (UCP 500) versions of the Uniform Customs and Practice for Documentary Credits with annotations for each appear in Appendixes C and D, respectively. Appendix E contains a number of illustrative documents that appear in letter of credit transactions with some frequency. These are not reproduced as forms but as examples of the various documents, so that persons unfamiliar with them will be able to see in detail the documents that courts are talking about and that a letter of credit may require. Appendix F is a basic document produced by UNCITRAL in connection with the drafting of the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit. This appendix includes the text of the convention with helpful discussion of UNCITRAL deliberations in connection with the drafting of the convention. Appendix G is the interpretive ruling of the U.S. Comptroller of the Currency that guides nationally chartered banks and that has influence in state bank regulation dealing with letters of credit. Appendix H is the International Chamber of Commerce (ICC) Uniform Rules for Demand Guarantees; and Appendix I is the ICCs Uniform Rules for Bank-to-Bank Reimbursements Under Documentary Credits. Appendix J sets forth sections of revised Uniform Commercial Code Article 9 that relate to letters of credit. Appendix K is the 1983 version of the UCP (UCP 400), which we have retained in order to provide

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the historical treatment of UCP provisions, many of which are part of the latest versions of the UCP, UCP 600 and UCP 500. The glossary is a comprehensive treatment of letter of credit terms drafted with a view to making it easier for nonlawyer bankers and nonbanker lawyers to deal with this work and the letters of credit it covers.

CITATIONS
The text and footnotes refer to the Uniform Customs as the Uniform Customs or the UCP. We have taken care to differentiate articles in UCP 600 and those in UCP 500. Occasionally, the cases we discuss rely on earlier versions of the UCP, and we have endeavored to make those references clear. References to the Uniform Commercial Code (UCC) are generally to the official version, unless dates indicate the contrary. The text often refers to Revised Article 2, though that revision has not as of this writing been adopted by any of the jurisdictions. Frequently, those citations will also refer to the prerevised version of that important article, which remains the source of sales law in the United States.

ACKNOWLEDGMENTS
The first edition of this treatise in 1984 was some four years in the making. Changes in the Uniform Customs and the Uniform Commercial Code prompted revisions in 1991 and 1996. These and more than thirty-five supplements over the last twenty-three years were an effort to keep pace with the dynamism of this corner of commercial law. None of these would have been possible without the support of family and a host of practitioners, bankers, academic colleagues, and especially librarians and support staff of the seven law faculties where I have taught and studied over that period. Ive acknowledged many of those folks in earlier editions and want to recognize a few signal contributions over the ten years since the last revision. First, are deans who provided financial support through research grants for this work and other publications: James K. Robinson, Joan Mahoney, Frederica Lombard, and Frank Wu. Generous gifts from the Law Schools graduates and friends made that support possible. In addition, the Universitys President, Dr. Irvin D. Reid, named me a University Professor and supplemented the decanal research support with University grants. These votes of confidence typify Wayne States commitment to scholarship and academic research. They made this treatise possible. Finally, it is fitting to add the names of several people for their personal loyalty over the last ten years or 5/07

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longer: Professor Benjamin Geva, Professor Agasha Mugasha, Professor Xiang Gao, Professor Filip De Ly, Ms. Catherine Dillon, Dr. Ali Goksu, and Dr. Jamel Baccar. To all of them and to many not named here, warm thanks.

John F. Dolan Detroit, Michigan March, 2007

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